September 06, 2012

Guild Investment Management

Sep. 6, 2012, 2:57 PM

Tape Readers - the Markets Seemed to Know What Bernanke Would Say

It was as a boy in the late 1950′s that I first became interested in the stock market. As part of my self-education about the stock market, I read many books about the historical luminaries of investing, colorful figures such as J.P. Morgan, Cornelius Vanderbilt, Jesse Livermore, Jay Gould, "Bet a Million" Gates, and others. In the past, many of these successful investors were called "tape readers."

In those days stock prices went across a ticker tape. They watched the price action of the market as a whole rather than focusing on charts of individual companies. These market players would judge the stock market's reaction to good and bad news by how it acted before and after such news was announced.

Reading the tape…no high frequency trading back then

Why do I bring this up in this letter? Because the last two months have been a very good example for how bad news does not seem to be able to cause stocks to fall. Any tape reader will tell you that stocks as a whole are rising and the market is gaining in internal strength, even though volumes have been low. This has been happening in spite of a seasonal tendency to lower prices in September, mediocre economic news, and fears about Europe's ongoing banking and sovereign debt crisis.

This week it became obvious why markets are acting well in spite of the problems or potential problems mentioned above. To set the stage, central banker Mario Draghi of the European Central Bank stated a few weeks ago, "We will do whatever it takes to defend the Euro… believe me, it will be enough."

Federal Reserve Chairman Ben Bernanke spoke last Friday in Jackson Hole, Wyoming. Here are some of the newspaper quotes that followed his speech: The LA Times said, "Bernanke gave a spirited defense of Fed policies and left little doubt that the central bank was preparing new stimulus for the economy… Bernanke expressed his dissatisfaction with the weak recovery and in particular with what he described as the painfully slow improvements in the job market." The Financial Times cover on Saturday said, "Bernanke Signals Fed is Ready to Act." It wasn't just the public press; Wall Street economists also chimed in. Credit Suisse sent a research report to its clients over the weekend titled "Bernanke Vigorously Defends Unconventional Policy."

Bernanke's speech defended past stimulus programs, pointing out how they had helped to lower mortgage rates and raise stock prices. The message was clear: Bernanke went on record that QE has worked… and more is coming. It was obvious to all listeners that he is signaling further non-typical intervention ahead.

This is no surprise to us. We have long believed and frequently stated to readers that before the European bank deleveraging and economic crisis in the developed world is over, central banks (including the Fed) will be buying stocks and other non-bond assets to stimulate demand and to improve the national business and investment psychology. Given the news backdrop, no wonder tape readers are buying the dips and not worrying about whether we will get another September market swoon.

Where There is Smoke, There is Fire

"Bundesbank Chief Jens Weidmann Threatens to Quit," read last Friday's German tabloid, Bild. After reports surfaced that Mr. Weidmann had contemplated resigning "several times," Weidmann followed up the rumors by saying to the more respected German magazine Der Spiegel that he "won't comment on speculations."

In our opinion, it seems that Mr. Weidmann is angry about the acceptance of ECB president Draghi's ploy to bail out the European sovereign nations and banks. To us it appears probable that Weidmann is on the losing side and may well be saying to himself: "Hey, I have lost the battle to keep QE from happening on a big scale in Europe, so why preside over an outcome I do not want? Is it wiser for me to quit?"

Enter the politics… Politically, it would be a disaster if he quit and his quitting would cost Chancellor Merkel of Germany dearly. She has had two other prominent economists quit in the past year over ECB monetary policies. It is likely that Weidmann is being talked into staying for appearances' sake. Mrs. Merkel told German ARD television that she welcomes Weidmann's input, and praised him for continuing to "make demands on policymakers."

Our Opinion

The following represents our opinion on the subject. It is becoming clearer every day that QE will be the course of action in Europe, Japan, the U.S., and many other countries. We need only to look at the recent strong price action in gold to confirm that others share this view. The markets are speaking. One of the things they are saying is that the hawks opposed to QE are losing in the halls of government...to read the full story become a gold subscriber today, click here

Wall Street has certain banks that provide plumbing infrastructure for money flows and trade settlement flows between brokers, and between brokers and clients. Most small stock brokers do not do their own back office clearing. Clearing (the handling of money and trade settlements) is done by professional clearing firms and large banks. JP Morgan is one of the biggest. Clearing and settlement of stock market buys and sells involves standing between buyers and sellers and providing the infrastructure for trades involving tens of billions of dollars a day in stock market and bond market transactions (commodity brokers typically have different arrangements and their regulation is done by different government agencies).

JP Morgan has become more risk averse. When Knight Capital almost went broke a few weeks ago (and had to go out and raise several hundred million dollars via a stock sale to stay in business), JP Morgan was not willing to accept thousands of Knight's owned securities while Knight was trying to line up financing. Knight eventually got the money via a stock sale to other investors, but JP Morgan's actions spoke volumes.

We expect this type of risk-diminishing behavior to become more widespread by clearing and settlement firms. We expect more and more companies to cut back the number of clients they serve with their clearing and settlement business. Clearing and settlement is a utility type of business, with low fees and a large volume of transactions. The business can be very profitable, but the risk of insolvency of their brokerage customers is real. If one of their brokerage customers was to go bankrupt, the clearing agents could be saddled with immense losses. Quite logically, clearing firms do not believe that their low fees compensate them for these major risks.

Why do we mention this to our readers? If JP Morgan and others who provide basic plumbing for stock money flows are nervous about the brokers they do business with, shouldn't you also be careful where you keep your stocks and bonds in excess of the SIPC insured amount?

If you are uncertain about the risks you are taking, feel free to contact us and we will share some information that we have gathered as a result of asking our securities attorneys to check the safety of asset provisions and administrative procedures of numerous financial institutions.

A further note for those who wish to register long-term positions in the beneficial owner's name, and not in street name with a broker: If you hold long-term positions in gold shares that you wish to keep away from short-sellers and to provide security for your position, you may want to change your holdings to another type of custodian. If you are going to hold the shares for long term (and the shares are not in an IRA or other type of account that requires an administrator/custodian) then the shares do not need to be held at a broker. They can be in your possession, or in your safe deposit box.

More Good News for Europe

In the Saturday, September 1st New York Times, James Kanter wrote about the latest news that the markets should welcome. "The European commission insisted on Friday that 6,000 banks in the Euro area be centrally supervised to prevent future financial crises…" While there are many details to work out, centralizing the bank supervision in Europe, especially of Greek, Irish, Spanish, and Italian banks would have helped defuse the current Euro sovereign debt crisis much sooner. It is still not too late. If implemented correctly, a centralized banking regulator with some teeth would be a good idea. An independent regulatory body could do a great deal to make investors more confident and encourage them to put money into recapitalizing European banks and European financial companies.

We will write more extensively about European bank supervision and the chances of its implementation in coming weeks.

Where the World's Energy Arteries are at Most Risk

The Chokepoints

The Strait of Hormuz

Bab el Mandab/Suez Canal/SUMED Pipeline

Strait of Malacca

The Turkish Straits

The Panama Canal, the Danish Straits

What does this mean for world energy and world energy prices?

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Facebook Shares Hit $18

One of our goals in these letters is to provide investors with information and thoughtful analysis early. In our May 17, 2012 letter, which was published before Facebook's less than auspicious public offering, we included a piece from Francis Gaskins, who runs the new issue rating service www.IPODesktop.com. As you remember, this past May there was a lot of hype about Facebook's new issue. People were clamoring to own a piece of the company that was going to be valued at over $100 billion. The shares were eventually priced at $38 on the IPO on May 18th; and they traded as high as $45 the first day (giving the company a market capitalization of about $120 billion).

Francis deserves kudos for his prescience. IPO Desktop's analysis of where Facebook shares could trade has been right on, and this serves as a reminder to all of us why it is important to do homework when investing. As we printed in our May 17th letter, Francis wrote:

"IPO Desktop acknowledges a $44 price could occur. However, IPO Desktop's view is that in six to nine months the shares could be at $18, based on an analytical valuation for the company of $50 billion, or 50 times 2011 earnings."

Francis' $18 price target was hit in about three and a half months.

Facebook may have carved out a very important niche, may have almost 1 billion users, may be very profitable, and may have a phenomenal internet presence, but that did not mean it was worth over a hundred times expected earnings. At the time of its IPO, hype drove the valuation too high. Not everybody realized it was over-priced, but some did…and avoided a fifty percent haircut.

Track the price of basic needs www.gbni.info

Summary-Key News as of Today…

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